Sympathy for the Devil

Please allow me to introduce myself
I'm a man of wealth and taste
I've been around for a long, long year
Stole many a man's soul and faith

...

Pleased to meet you
Hope you guess my name
But what's puzzling you
Is the nature of my game

— The Rolling Stones, "Sympathy for the Devil"

I recently received an inquiry from an unnamed Professor at an anonymous law school, Dear and Long-Suffering Readers, who requested I grant his charges an interview or appearance. Demurring on the latter, since the effects of surgery to remove horns, tail, and cloven hooves have not completely healed, I elected to do the former. What can I say? After Charlie Green plied me with peyote and Balinese dancing girls, I appear to have gone all soft in the head, and am granting interviews left and right. I worry for my long-term reputation.

Anyway, Herr Professor Doktor steered his chicks toward my most recent post but two, on the vagaries and trials of travel as one of the Übermenschen, and suggested they ask me questions to their little hearts' content. HPD collected and transmitted said queries, which I have represented here, in lightly reordered and edited form, along with my discursive replies. Perhaps these nuggets will answer one or two unresolved questions in your own befuddled brains, or even while away some dull hours of a Sunday evening. I wish you joy of them.

What else were you gonna do tonight? Watch the Oscars?

* * *

Q: Do you hate your life, and if you do, do you simultaneously realize how good you have it?

A: No, I don't hate my life. Compared to most people, I know I have it pretty sweet. Could it be better? Of course. Is my job all fun and games? No, but overall I would not trade it for any other means of making a living I am aware of. A cushy retirement, on the other hand...

Q: What percentage of your job/income is built on intelligence, and what percentage of your job/income is built on bullshit?

A: Your question appears to presume that intelligence and bullshit are mutually exclusive. That has not been my experience in the real world at all. There is such a staggering quantity of bullshit floating around in the spheres of commerce, culture, and politics, that I find the occasional example of intelligent bullshit to be a pleasure and a relief. I pride myself on trying to increase its stock in the world, for others' entertainment and amusement. This applies to work, as well, where I would estimate the ratio to be 75%/50%.

Q: If your clients are constantly owning you bankers, when do they have time to own their lawyers?

A: Clients appear to have a practically unlimited capacity to own (or feel they own) their professional advisors. It's almost magical. The fact that one owns me does not impinge on his ability to own his lawyer too. On the other hand, bankers like me typically only swoop in for periods of limited duration, usually in connection with a transaction, so a client really only rents me. His lawyers, on the other hand, he owns outright in perpetuity: lock, stock, and barrel.

Q: Of the investment bankers you've worked with who are also attorneys, how do they add typically add value, if any, by virtue of having a legal education?

A: First of all, you can't bank and practice law at the same time. Regulators tend to frown on such things. However, bankers who have legal training and who have practiced law before can be quite effective in certain capacities. A trained mergers and acquisitions lawyer tends to be more technically proficient at M&A, and a trained securities lawyer can be more effective in arcane areas like structured finance than your average non-lawyer banker. But technical proficiency alone is not enough. Among other things, you need to be a good salesman. In my experience not all lawyers have that personality or skill. Those who do, and who can make the transition to a business predicated on eating what you kill, rather than slaving away at a sinecure, tend to do very well.

* * *

Q: Since you are apparently dissatisfied with the efficiency of your chosen line of work, what suggestions would you have for improving the efficiency?
– and –
Q: Would you say this seemingly inefficient client relationship model is where most of the “fat” is in investment banks, or some other traditional way of doing business?

A: I am not sure I agree with your premise that a client service business can be "efficient." There is a lot of sucking up and relationship building to do with my clients, in addition to actual deals, and sucking up in my experience is relatively time-inelastic. There is much wasted time, and many false starts, but those come with the territory of any business predicated on large, intermittent transactions. Like the Army, investment bankers do a lot of hurry-up-and-wait.

Unlike the Army and many other businesses, however, there usually isn't an enormous amount of bureaucratic fat or organizational sclerosis in an investment bank. We tend to recreate and retool ourselves too often in pursuit of the almighty buck to let much moss grow. When it does, however, it tends to happen at the biggest universal banks. Citigroup is perhaps the poster child for what happens when bureaucracy and inertia are allowed to take over an investment bank. It isn't pretty.

Q: You focus on the "pressing the flesh" aspect of your job mostly in this post. Is this what you spend most of your time at work doing, or is there another aspect of your job that you spend more time on?

A: It's important to understand just exactly what I mean in this regard. I do spend a great deal of my time with clients, traveling to them, and working on deals in their presence. But I do comparatively little of the traditional client entertainment—wining and dining, golf outings, $50,000 "bar" tabs at Scores—that you might think I do. In fact, I would guesstimate that investment bankers on average do less of this than many other professionals.

However, we do spend a lot of face time with clients both selling and doing deals, because when the future of your company, your career, and your net worth is on the line—as it often is in M&A deals and major capital raisings—the client justifiably wants to see the whites of his banker's eyes. Very little of what we do can be done solely by conference call or email. The client wants to meet us, look us in the eye, and shake our hand before he puts his fate in our hands. In large part, it is an issue of personal trust.

Q: Given [your heavy travel] schedule, how does a senior level banker adequately digest all of the research and information necessary to provide the client with a researched and informed pitch? It seems as though this working situation does not lend itself to a quality work product.

A: One word: subordinates. Seriously, I and every senior investment banker out there relies heavily on junior bankers for research, facts, financial analysis and modeling, and pitch preparation. We could not do our jobs without them.

But it's important to realize that the value I bring to a potential client or transaction is not entirely dependent on facts or analysis. The secret sauce I bring is my extensive, two-plus-decade knowledge of an industry, its participants, the executives in it, and the dealmaking and capital raising scenarios possible within it. That is network knowledge, which is not limited to shareholder lists, valuation ratios, or CEO resumes. Those are facts. Facts are critical to get right, but facts are, in the most important sense, trivial. What matters more is the mental model you plug those into; it is the network map which spits out the interesting answers.

Along these lines, you may now understand that all the travel I and my senior colleagues do—the deal pitching, the flesh pressing, the occasional schmoozing—is actually critical to maintaining our network knowledge. A client visit isn't a waste of time. It's research.

* * *

Q: You said dealing with Private Equity professionals is not all peaches and cream. What are the typical tensions between Private Equity and Investment Bankers? Is it just two egos constantly butting heads?
– and –
Q: Is it that hard to move into a position where you would be dealing with financial sponsor coverage? Would you want to, and if so, why haven't you?
– and –
Q: How is dealing with private equity firms a curse?

A: Private equity professionals are their own breed. While many of them used to be investment bankers, the nature of their job is quite different. They are tasked with investing other people's money in long-term, illiquid businesses through leveraged buyouts and the like: they are investors, not bankers. Many if not most of them are quite smart, but they are usually nowhere near as smart about any particular subject or industry as they think they are. Like most people who come from a background which they are happy to have escaped, they tend to sneer at people who still work there. They tend to look down upon us lowly investment bankers as a necessary evil.

If they have a dominant personality flaw, it is overweening arrogance. The successful ones are far richer than the successful investment bankers, but, as in banking, the number of truly exceptional and successful private equity professionals is much smaller than they think it is, and usually does not include the person expressing the opinion at the time. As you might be able to tell, I am not the best banker to assign to stroking these individuals' egos, no matter how much money they tend to pay investment banks in fees. I have my own arrogance to contend with, and that is not a good personality trait for a sponsor coverage banker.

Q: Looking back, how many of your clients (as a rough percentage) would you say have a good understanding about corporate finance and what is "best" for their companies in terms of equity versus debt and which types of securities to issue?

A: Technical proficiency with the tools and techniques of corporate finance? About 50%, with most (although not all) of those at larger companies. Strategic competence and vision—i.e., top-flight Chief Executive and Chief Financial Officers who make a real positive difference to the health and future prospects of their firms? Maybe 30%, at best, distributed almost randomly across size, scope, and nature of client. For do not forget: true value is created on the left side of a balance sheet—the assets of a firm, and how they are deployed—not in financial engineering of the right. The latter is important, but it's not where the real shareholder value rubber meets the road.

Q: What are some of the larger factors that you typically look at in a company when deciding what sort of deal to present to them?

A: I may be somewhat unusual in this respect, but I tend to like to listen to what the client thinks and wants before I start offering ideas. Until I learn otherwise, I like to assume that the CEO and CFO know their business, their competitors, and their opportunities and threats better than I do. Perhaps this humility costs me lost deals, but it certainly raises me in most executives' estimation as something more than just one more goddamn investment banker.

* * *

Q: Did your educational background play a significant role in preparing you for the real-world experience, or has that been something that you have had to learn on your own?

A: Not really. My undergraduate degree was in something completely unrelated to business or finance. My MBA provided no more help than to open the door to investment banking: an entrance ticket, or table stakes. You have to be able to communicate in my business, and it's hard (but not completely impossible) to get by without some basic level of numeracy, but I have seen people from all sorts of educational background succeed and fail in this business. A lot of it boils down to sheer grit and determination.

Q: You speak of the negative attributes of the lives of investment bankers, but what positives attributes of the job (if any), other than the money entice someone to remain in such a high-paced and high-pressured field?
– and –
Q: You tell what you thought your career would be like and what it is actually like. Are you disappointed at all? Would you change anything about your career?
– and –
Q: If were feasible for you to start over, would you choose another career? If so, what?

A: Let me tell you something: unless you're raking in Lloyd-Blankfein-level bucks, the money just isn't enough for what I do. Especially when you try to keep up with the Blankfeins and the Schwarzmans in a crazy burg like Manhattan. But that's my choice; I do not expect or deserve any sympathy on that account.

More importantly, money is not the only reason I have stayed in investment banking for over 20 years. The job is challenging, intellectually stimulating, and often a sheer blast. It's fun to work balls to the wall, day and night, for weeks on a big deal and see it hit the tape on Monday morning. It's fun to yell and scream at some numbnuts across the table at a negotiating session. It's fun to think up a multi-billion dollar transaction, initiate it, and see it to conclusion. And, notwithstanding what I said before, it's fun to fly home first class from Asia, swilling vodka tonics and watching Japanese films on DVD for 20 hours. My job can be a goddamn hoot.

Of course, it hasn't all been peaches and cream. If I could wish for one thing in my career, it would be for a few more big deals to have broken my way. On such serendipities careers—and true fortunes—are made. But I can't complain. It's been a good ride, and it's not over yet. If I started something new, it wouldn't be to make money. Maybe blogging...

* * *

Okay, kiddies. That's all for now. Happy lawyering, and if you meet me on the street one day, I suggest you tip your hat.

So if you meet me
Have some courtesy
Have some sympathy, have some taste
Use all your well-learned politesse
Or I'll lay your soul to waste, mmm yeah

© 2011 The Epicurean Dealmaker. All rights reserved.

Do You Trust Me?

When I ventured my first tiny, baby steps onto the internet over four years ago, O Dearly Beloved, one of the first sites I stumbled across was Trust Matters, the blog of my friend Charles H. Green, the Trusted Advisor. Charlie, as the cleverer among you might be able to discern, makes a living writing and consulting about trust-based selling in particular and the role and nature of trust in business and life in general. I have followed his site off and on over the intervening years, first because he addresses issues I find thought-provoking in and of themselves, and second because a good salesman—which is what I style myself to be—is always looking for tools and techniques to improve his results. I have always found what Charlie has to say on the subject worth a read.

Anyway, Charlie approached me recently to ask if he could interview me for a series on trust that he was running on his site. Having caught me in an uncharacteristically equable mood, I agreed. (I blame the peyote.) The result can be found here. Charlie asked me lots of questions, about my industry, financial markets in general, and the role of trust in both. I pitched my answers at a relatively general level, in order not to suffocate Charlie's regular audience of normal human beings with too much jargon or insider arcana. I should also warn my regular readers that I behave quite differently there than I do here. (I would not want one of you to click over there and have an aneurysm from my lack of outrageous language or behavior.)

* * *

There is one excerpt I thought would be useful to include on this site, since I do not think I have addressed this issue directly in these pages before, although I have done elsewhere: pseudonymous blogging. Here is what I have to say on that subject:

CHG: Let’s deal with one sideways issue, the question of anonymity. Some commenters on this blog have been critical of anonymous bloggers. I think anonymity can play some interesting roles, and in some ways can be critical. You’re an anonymous blogger; your view on the subject?

TED: Anonymity can indeed foster all sorts of bad, irresponsible behavior, and I am not in favor of it in general. But blogging (or even commenting on another blog) under a pseudonym, as I do, is very different. Anonymity means no identity; pseudonymity means a false or assumed identity.

For one thing, operating under a pseudonym allows one to build up a corpus of opinion that can be judged in toto. Third parties can develop an opinion of your credibility and the value of your opinions for the very reason that you present a consistent identity, that you do in fact have a name. That this name is false, and a mask, is more a matter of convenience and perhaps professional necessity than it is of deception.

If people judge my words and opinions interesting, provocative, and worthy, it does not really matter whether they know me as TED or Joe Smith. One can always worry that a pseudonymous commenter or blogger has an ulterior agenda, but I suspect that is both hard to conceal over a long period of time (I have been blogging for over four years) and, frankly, beside the point. I challenge you to find anyone commenting in public who does not have at least one unstated agenda. And yet we should be able to judge and evaluate each other’s contributions nonetheless.

I claim to be an investment banker with over 20 years experience in the business. I claim many other things besides. Neither you nor anyone else really knows this to be true or not, and yet I hope my words and opinions themselves have earned me a measure of trust in this respect that a resume or a photograph would not add to. Perhaps I am naïve, but I believe that, given enough time, trust can be built upon words alone. My entire career testifies to that belief.

There is much, much more on Charlie's site. Feel free to visit it and learn something. I know I did.

P.S. – Notwithstanding what I say in the interview, I am not really Joe Smith. He's just some guy who owes me money. And the picture Charlie used just doesn't do justice to me. I am nowhere near as tan as that guy.

Cheerio.


© 2011 The Epicurean Dealmaker. All rights reserved.

Weekend Interlude

Honor to those who in the life they lead
define and guard a Thermopylae.
Never betraying what is right,
consistent and just in all they do
but showing pity also, and compassion;
generous when they are rich, and when they are poor,
still generous in small ways,
still helping as much as they can;
always speaking the truth,
yet without hating those who lie.

And even more honor is due to them
when they foresee (as many do foresee)
that in the end Ephialtis will make his appearance,
that the Medes will break through after all.

— C.P. Cavafy, "Thermopylae"

In the end, Ephialtis always appears, and the Medes always break through. We bring them with us when we come to Thermopylae.

They are us.

© 2011 The Epicurean Dealmaker. All rights reserved.

Come Fly With Me

Come fly with me, let's fly, let's fly away
If you can use some exotic booze
There's a bar in far Bombay
Come fly with me, let's fly, let's fly away

Come fly with me, let's float down to Peru
In llama land there's a one-man band
And he'll toot his flute for you
Come fly with me, let's take off in the blue

— Sammy Cahn and Jimmy Van Heusen, "Come Fly With Me"

The life of an investment banker can be a peripatetic one, Dear Readers. That is certainly the case for Yours Truly. While there is no real regularity or predictability to my travels—either in terms of frequency, destination, or duration—it is true that I am often on the road. My jaunts usually take the form of quick in-and-out sorties or multi-day trips to a number of different cities. I am rarely away from the office for more than two or three days at a time, although it is not uncommon for me to land in New York on a weeknight, go home to sleep, and turn right around to the airport for a flight out the next day. Most investment bankers travel like I do, in short, intermittent bursts. We are not the crazed road warriors that management consultants can be, traveling 330 days a year or spending six weeks at a stretch in a Motel 6 in Dubuque, Iowa conducting middle management training sessions. Thank God.

But not all investment bankers travel. A great number, like the salesmen, traders, and structured products weenies on the trading floor almost never leave town. Their ambit of travel usually consists of a well-worn circuit from home to office to bar to mistress to home, with an occasional drunken "client dinner" with trading counterparties thrown in for good measure. Only the client-facing product bankers, who help relationship and advisory bankers like me flog specific capital markets services like equity or debt underwriting to corporate customers, leave the office more than once in a blue moon.

And, depending on their client coverage and responsibilities, some senior bankers almost never leave their home base. Among the luckiest are those who manage the firm's relationships with private equity firms—usually known as financial sponsor coverage—in New York City. These guys and gals usually spend more time going up and down in elevators than they do in cabs or crossing the street. Of course, they are cursed with dealing with private equity professionals, so it's not all peaches and cream.¹

* * *

Naturally, we rarely let junior bankers out of the office at all. Junior bankers, like financial analysts and associates, spend most of their time chained to their desks, doing research, creating and updating financial models, and endlessly turning revisions of the 600-page presentation decks we Managing Directors inflict on our clients when we pitch for business.

Part of this is due to cost control: it just makes no sense to bring an analyst or associate to a pitch when you already have a client coverage MD, a senior product banker, a client-facing Vice President, and other assorted hangers-on. But a bigger part of it stems from the fact that most clients usually want to see the most senior investment bankers they can. They want to see some Hermes-clad multimillionaire on his knees in their office, sucking up to them, their pissant company, and their pathetically ill-conceived strategic plans before they give him a new piece of business. If you were in the position of signing a piece of paper that would give the obsequious wretch sniveling across the table from you tens of millions of dollars for six weeks' work, you would too.

Once the engagement letter is signed, however, the client will be lucky if he sees the Managing Director who pitched for his business again before the closing ceremony. After all, we Managing Directors have to move on to the next pitch, and the next new piece of business, if we ever expect to get paid the excessively rich compensation we have promised our wives and mistresses we would earn. Eventually, the client learns that the Vice President or Senior Associate sitting in his office with his Treasury staff or Corporate Development Officer is smarter and harder-working than the Managing Director is anyway. It all usually works out just fine.

* * *

Investment banking, at the end of the day, is a sales-driven business. The higher up you move in the chain of command, the greater your new-business-generation responsibilities become, and therefore the more time you usually spend on the road pressing the client flesh. That is a non-obvious feature of the business, and it caught Your Dedicated Correspondent somewhat by surprise. As a junior weenie banker, I always expected that my workload would decline as I rose in the organization, and certainly the sheer amount of work and hours associated with it have done. But what I didn't realize was that the higher I rose, the closer I got to the client, who is the ultimate authority in our business and the person who decides when, where, and how high you must jump. The bigger you get in my business, the more the client thinks he owns you.

So you get some pretty silly outcomes, especially when you are pitching new business. I think the most egregious example was the time I had to fly 18 hours, on short notice, from a mid-sized European city to Beijing for a two-hour pitch and fly right back to London for business the next day. In terms of cost-effectiveness, best use of senior bankers' time, and sheer expense, this was pretty ludicrous. But it is not the only such example I could share with you.²

Let's just hope Saint Peter doesn't have an up-to-date carbon audit for Yours Truly when I finally roll up to the Pearly Gates. Cause if he does, I am so fucked.


¹ I knew one senior banker, wearied out from years of flying all over the world as an M&A banker, who jumped ship to another bank to specifically cover financial sponsors in Manhattan. He was looking forward to having his daily commute to and from Connecticut be the extent of his travel regimen. Naturally, his new employer's promises never panned out, and the poor man spent more time in planes than at home until he finally retired. Never, ever trust an investment bank's employment promises.
² Also, for the avoidance of doubt, let me correct those of you who are absorbing this story and the description of my frequent travel with relish, and who think, "Gee, how exotic and glamorous that is." Domestic and international travel like this is fun and exciting for about the first year or two you do it. After that, you just turn into a cranky wretch who cares about nothing but snagging an upgrade to first class (unpaid by your employer, by the way) so you can drink yourself into a stupor on your miserable journey. For all the exotic international destinations I have visited for work in the past 20 years, they all look surprisingly the same: an airport, a taxi, a hotel room, a conference room, a taxi, and an airport. Only the view rushing by outside the window changes.

© 2011 The Epicurean Dealmaker. All rights reserved.

Sic Semper Tyrannis

February 11, 2011:

Westmoreland:

O that we now had here
But one ten thousand of those men in England
That do no work to-day!

King:

What's he that wishes so?
My cousin Westmoreland? No, my fair cousin.
If we are mark'd to die, we are enow
To do our country loss; and if to live,
The fewer men, the greater share of honour.
God's will! I pray thee, wish not one man more.
By Jove, I am not covetous for gold,
Nor care I who doth feed upon my cost;
It yearns me not if men my garments wear;
Such outward things dwell not in my desires;
But if it be a sin to covet honour,
I am the most offending soul alive.
No, faith, my coz, wish not a man from England.
God's peace! I would not lose so great an honour
As one man more, methinks, would share from me
For the best hope I have. O, do not wish one more!
Rather proclaim it, Westmoreland, through my host,
That he which hath no stomach to this fight,
Let him depart. His passport shall be made,
And crowns for convoy put into his purse.
We would not die in that man's company
That fears his fellowship to die with us.
This day is call'd the feast of Crispian.
He that outlives this day, and comes safe home,
Will stand a tip-toe when this day is named,
And rouse him at the name of Crispian.
He that shall live this day, and see old age,
Will yearly on the vigil feast his neighbours,
And say, "To-morrow is Saint Crispian."
Then will he strip his sleeve and show his scars,
And say, "These wounds I had on Crispian's day."
Old men forget; yet all shall be forgot,
But he'll remember with advantages
What feats he did that day. Then shall our names,
Familiar in his mouth as household words,
Harry the King, Bedford, and Exeter,
Warwick and Talbot, Salisbury and Gloucester,
Be in their flowing cups freshly rememb'red.
This story shall the good man teach his son;
And Crispin Crispian shall ne'er go by,
From this day to the ending of the world,
But we in it shall be remembered,
We few, we happy few, we band of brothers.
For he to-day that sheds his blood with me
Shall be my brother; be he ne'er so vile,
This day shall gentle his condition;
And gentlemen in England now a-bed
Shall think themselves accurs'd they were not here,
And hold their manhoods cheap whiles any speaks
That fought with us upon Saint Crispin's day.

— William Shakespeare, The Life of Henry the Fifth

* * *

Allahu Akbar...

Praise to you, the people of Egypt, for throwing off your long chains. Praise to you for placing your bodies in the path of men with bullets and machines. Praise to you for giving your blood for your childrens' future. Praise to you for joining hands against the tyrant with your brothers and sisters of all faiths and creeds. God is great. You are great.

May you now have the courage to grow into your greatness.

Allahu Akbar...


© 2011 The Epicurean Dealmaker. All rights reserved.

Three Things

Look, the trees
are turning
their own bodies
into pillars

of light,
are giving off the rich
fragrance of cinnamon
and fulfillment,

the long tapers
of cattails
are bursting and floating away over
the blue shoulders

of the ponds,
and every pond,
no matter what its
name is, is

nameless now.
Every year
everything
I have ever learned

in my lifetime
leads back to this: the fires
and the black river of loss
whose other side

is salvation,
whose meaning
none of us will ever know.
To live in this world

you must be able
to do three things:
to love what is mortal;
to hold it

against your bones knowing
your own life depends on it;
and, when the time comes to let it go,
to let it go.

— Mary Oliver, "In Blackwater Woods"

A poem can be many things: an elegy, a lament, a cry from the heart, a prayer. Sometimes it can be all of these things at once.

But often, all one can really hope is that the right poem can comfort a heart wracked with pain and worry. Here's hoping that is the case now.

Amen.


© 2011 The Epicurean Dealmaker. All rights reserved.

Pay Close Attention, Ladies and Gentlemen...

Any sufficiently advanced technology is indistinguishable from magic.

— Arthur C. Clarke

A little while ago, a fellow named Omer Rosen wrote a little piece entitled "Legerdemath" in the Boston Review. Mr. Rosen apparently used to work for Citigroup at the beginning of the Oughts, on its corporate derivatives desk. As a fresh-faced young tyro, Mr. Rosen spent three years selling mostly "mundane interest-rate swaps and Treasury-rate locks" to corporate clients of the bank. Mr. Rosen does not seem to have walked away from this experience with a good feeling about the work he and his colleagues did there.

In fact, his piece created a minor flurry of attention on Twitter and elsewhere, because it paints the activities of Citigroup's derivatives desk in a very unflattering light. Mr. Rosen writes:

Our clients were non-financial corporations, the Deltas and Verizons of the world, which relied on us for advice and education. Our directive was "to help companies decrease and manage their risks." Often we did just that. And often we advised clients to execute trades solely because they presented opportunities for us to profit. In either case, whenever possible we used our superior knowledge to manipulate the pricing of the trade in our favor.

I never heard this arrangement described as a conflict of interest. I learned to think we were simply smarter than the client. For unsophisticated clients, being smarter meant quoting padded rates. For the rest, a bit of "legerdemath" was required. Most brazenly, we taught clients phony math that involved settling Treasury-rate locks by referencing Treasury yields rather than prices.

If a client requested verification of our pricing, we volunteered to fax a time-stamped printout of market data from when the trade was executed. One person talked to the client on the phone while another stood by the computer and repeatedly hit print. The printouts were sorted, and the one showing the most profitable rate for the bank was faxed to the client, regardless of which rate was actually transacted. If a rate for the client's specific trade was not on the printout, we might create rigged conversion spreadsheets for them to use in conjunction with the printout.

Other sources of profit lay in details that clients thought were merely procedural but in actuality affected pricing as well. Once, a client called after his interest-rate swap was completed and asked to change a method of counting days. Unbeknownst to him, this change should have lowered his rate. I made the requested change but kept his rate the same, allowing us to realize unwarranted profit. This was standard practice. My coworkers knew what I had done, as did the traders, as did the people who booked trades. I even tallied the "restructuring" as an achievement in a letter angling for a higher bonus.

Given in what high esteem Wall Street and its employees are currently held in this country and elsewhere, Dear Readers, you can just imagine how this description was received by the chattering classes. Fraud! Deception! Very Naughty Banks Behaving in an Unmistakeably Despicable Fashion! Mr. Rosen's story was taken as almost perfect confirmation of what everybody already knows: that investment banks are completely out for themselves, and that they try (and mostly succeed) to swindle their clients every chance they get.

Sounds good. Too bad that storyline is complete bullshit.

* * *

First, a little background. As I have said many times before, investment banks' businesses can be characterized in one of two ways: agency businesses, where the bank acts on behalf of a client to execute a transaction and earns a fee for doing so, and principal businesses, where the investment bank acts as a counterparty to its customer, and earns a profit or loss on a trade. Traditional investment banking businesses like mergers & acquisitions advisory and securities underwriting fall squarely in the agency camp, whereas full-blown proprietary trading, in-house hedge funds, and in-house private equity funds fall squarely on the side of principal activities. Traditional market-making—where an investment bank stands ready to buy or sell existing securities, commodities, and derivatives for trading customers who want to execute the other side of the trade—can range from relatively riskless agency-type business, where the bank takes on very little inventory or balance sheet exposure to changing market prices, to much more proprietary operations, where the bank hopes and expects to make a profit by holding market positions for more extended periods of time.

But there are hybrid businesses within investment banking, as you might expect from an industry which never discovered a profit-making opportunity it didn't like. One of the most important of these is structured products, in which banks take off-the-shelf and proprietary securities and derivatives and slice, dice, and recombine them into customized instruments that they can then sell to corporations or investors. For corporate customers, these are usually marketed as the solution to some particular asset or liability management problem the company has—like, in the simplest instance, turning a fixed rate borrowing into a floating rate obligation via a fixed-to-floating swap. For (usually institutional) investors, structured products are developed to create a customized or semi-customized investment return tied to various indices, underlying securities or commodities, or almost anything under the sun an investor wants to capture. Investment banks tend to be really good at creating structured products, both because they understand the underlying financial instruments and markets as well or better than anyone and because they have hired a raft of really, really smart propeller heads from academia and elsewhere who can manipulate the complicated maths required to structure them.

But look very, very carefully at the preceding description, O Dearly Beloved, and see if you can detect the pivotal distinction. Did you see it? Did you catch the sleight of hand?

But of course you did, because you are so clever. Structured products are just that: customized products, that are manufactured, marketed, and sold to customers. Now they may in fact be (and usually are) sold as solutions to some problem or opportunity the customer wants to address, but they are products nevertheless. And this bears crucially on the proper understanding of the relationship and obligations between the bank which creates and sells them and the customer which purchases them.

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Think about it. In agency business like M&A or underwriting, the agent-client relationship is clear: the bank is hired by a client to do something, and bears responsibilities and obligations to that client as its trusted advisor. There is no direct conflict of interest with the bank's fiduciary obligations to itself and its owners, since the bank assumes very little real risk in executing such transactions. At the other end of the spectrum, the bank conducts proprietary trades with counterparties. Each party to such a trade knows and expects to know little or nothing about the motivations the other may have or the other's potential profit or loss on the trade; they just bargain for the best possible price they can get.

But in structured products, we are talking about manufactured goods. The bank purchases the raw materials for a trade, creates a structure around these components which delivers a certain advertised set of performance behaviors and characteristics, and sells them to its customer. It sells a product. Accordingly, the customer which purchases a structured product from an investment bank is no more a "client" of that bank—benefiting from a trusted fiduciary advisory relationship—than I am when I buy a can of soda or an automobile. Now it's true that both regulation and norm require that the seller of a manufactured product deliver a good which performs as advertised, and which does not cause unforseen harm or adverse consequences. But Coca Cola or General Motors do not owe me, as the purchaser of their products, any sort of fiduciary obligation or particular duty of care.¹

Investment banks are guilty of blurring this distinction themselves, by casually insisting on using the term "client" to describe almost every entity they transact with, whether it is an M&A advisee or the purchaser of a forward start swap. But we are not alone in doing this. Remember the first time you went to look at houses or apartments with a real estate broker, and he or she called you a valued client? Do you also remember how soon you discovered that real estate brokers work for the seller or landlord, who are their real clients, and that you were just a sucker patsy customer? But no matter the particular circumstances, the economic and transactional roles are clear: if someone is selling you a product or a "solution," you are not a client. You are a customer.

And customers do not usually have the right or the ability to see into a seller's manufacturing process to see how the sausage gets made, what type and quality of ingredients are used, and whence the various sources and magnitudes of the resulting profit margin come. I don't know the kind and cost of ingredients that go into my Diet Coke, or the source and cost of the wiring harness in my Range Rover. Do you? Of course not. Manufacturers manufacture things to make a profit. The magnitude and source of that profit is, for me as a consumer, not even a secondary concern. My concern is to get a reasonable quality product which satisfies my needs for the best possible price.

I can try to mitigate the fundamental information asymmetry between the manufacturer of a product and me as buyer in one of two basic ways: I can try to educate myself about the product, and become a more sophisticated consumer, or I can set the seller up in price competition with one or more other sellers to get a better price. Both of these approaches become more difficult for structured products the more customized the product or solution at hand is. And both of these approaches are resisted heartily by the manufacturer, whether it be an investment bank, a soda pop company, or an auto OEM. (Since when did you see any business offer to forgo profits on its activities?) Unless a consumer can manufacture the good she requires herself, she is ineluctably at the mercy of the seller, mitigated only by her negotiating skills.

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So count me among the distinctly underwhelmed and non-outraged over Mr. Rosen's tale of woe. Show me examples of for-profit manufacturers that cheerfully offer their customers complete visibility on all their embedded sources of profit, or who refrain from a little game of hide and seek with customers who press them. The information games Mr. Rosen relates arise exactly because some investment bank customers try to become more sophisticated about their purchases, in order to increase their negotiating leverage over price. Some clients are indeed very sophisticated, and those tend to get the best terms and the best price. Most customers are not; they are price takers. But that is true of any market.

Mr. Rosen seems chagrined that he concealed information and misled clients about his employer's pricing. But where was his obligation to do otherwise? Unless he had a contractual obligation to provide true and transparent pricing to these clients, which would have been extremely unusual, there was none. And don't get your panties in a twist about the amounts involved here, either. We are probably talking about basis points, or fractions of a basis point, here. (A basis point is 1/100th of one percent.) There are enough sophisticated customers and enough price competition among investment banks in the structured product markets to have reduced banks' profit margins on the plain vanilla interest rate swaps and Treasury rate locks Mr. Rosen and his colleagues sold from the percent or two range that existed at the inception of the market to mere basis points today. That is one reason why banks have tried to engineer ever more complicated and sophisticated structured products over time: the profit margins are better.

I strenuously disagree with anyone who contends that apologists like me are trying to "retroactively apply caveat emptor principles" to this corner of the financial markets. They have always been in effect here. It is only the foolish and incompetent customer who did not realize it. I would like some of the self-appointed defenders of Corporate America or the assembled hedge funds and pension fund investors in the structured products market to go toe-to-toe with these alleged "victims" over the terms and price of a moderately structured security or derivative. Most Treasurers or portfolio managers I know would kick their asses six ways from Sunday. These are not dumb, lily-livered creampuffs who buy our stuff.

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Mr. Rosen was a young man, fresh from university, when he ventured into the bowels of Citigroup. Perhaps he became disillusioned at what he saw, like many young people who first encounter the petty concealment and manipulation which lies at the heart of any manufacturing or sales enterprise. But this is not fraud, Ladies and Gentlemen, and this is not something that doesn't happen a million times a day in almost every other manufacturing industry around the globe. This is not even capitalism. This is buying and selling, as it has been done since the first caveman traded his extra spear for a cooking pot.

So there you have it, Ladies and Gentlemen. Presto, change-o! I have turned this smelly old sock into a lovely vase of flowers. You may leave your money at the door. Nice doing business with you.


¹ Note that nowhere in his little narrative does Mr. Rosen claim that any of the products his desk sold to customers blew up or acted in any way not as advertised. It would have been rare for that to have happened anyway, given how simple and plain vanilla most of these products were, but note that Mr. Rosen does not claim Citigroup sold customers defective goods.

© 2011 The Epicurean Dealmaker. All rights reserved.